Here is a picture, taken from a paper by Ben Bernanke, which anyone resisting wage cuts in the Irish context today needs to take seriously. These are countries which (mistakenly) stuck to gold until the bitter end. Like ourselves, therefore, they did not have the option of devaluing. (No, I am not saying we should leave EMU.) The more wages fell, the less output declined. (And yes, the result comes through in regressions which control for other stuff.) The question today is, do we want to end up looking more like Belgium, the Netherlands or Poland, or like France and Switzerland?
Category: Economic Performance
An indication of the pressures on Ireland’s competitiveness is provided by the Harmonised Competitiveness Index, the December figure for which has recently been released on the Central Bank website. While the real HCI had been falling gradually since the early part of the last year (a rise in the indicator implies a disimprovement in competitiveness, while a fall in the indicator indicates an improvement), the December figure jumped upwards by 4.0% over the previous month, largely due to the appreciation of the euro particularly against sterling. The Dec 2008 value of 126 puts us back where we were at the beginning of last year.
It appears that the fear of a deflationary spiral is being used as a major argument against wage cuts. My impression is that the idea is gaining traction out there in the real world, and so it seems worthwhile restating the reasons why it is wrong.
‘The’ price level in the Irish context is the European price level, which is determined by policy in Frankfurt. Nothing that happens in Irish labour markets will move this price level by one iota in either direction, and so nothing that we do here will set off a deflationary spiral. What we can influence is a relative price, namely the relative cost of living and doing business here. This relative cost exploded during the bubble, and it will eventually come down. The only issue is whether this happens quickly, or whether relative Irish costs will be ground down by unemployment and stagnation over the course of many years.
David Begg is right to fear a deflationary spiral, but what will determine whether we get one or not is the relative supply of ideologues and pragmatists in the ECB, not anything that happens here. And the sort of intertemporal logic which explains why deflation is so damaging can be turned on its head in the Irish context: as Philip points out, it implies that wage cuts need to happen all at once, now.
The Government should announce that all public sector wages, which it controls, be cut by x%, where x is determined by real exchange rate considerations. It should strongly suggest that all private sector wages be cut by the same amount. Ideally we would all jump together, and so the wage cuts would come into effect simultaneously on a given date. St Brigid’s Day would seem appropriate.
Paul Krugman discusses the problem facing those EMU member countries that are currently suffering from a lack of competitiveness (note, by the way, his use of the word competitive!) and accepts that nominal wage reductions are a necessary part of the adjustment: you can read his discussion here.
He also links to a posting by Edward Hugh that probes the difficulties involved in engineering nominal wage reductions: you can read it here.
There is widespread agreement as to the policy errors that have compounded the current crisis. These include a pro-cyclical and politically driven fiscal stance, the failure to reform the tax system and tackle the house-price bubble, the first round of public-sector benchmarking and the weakness of financial sector regulation. There has been less analysis of the institutional and political economy factors that led us into these errors. I think a number of them can be seen to be interconnected. Thinking about these dimensions is necessary if we are to be saved from future crises.
Philip Lane (1998) and Colin Hunt (2005) have shown that some components of Irish fiscal policy at least have been pro-cyclical since at least the 1960s, and we stand out in this in comparison with much of the rest of Europe. I don’t think the political economy reasons have been fully identified, but McCreevy’s dismissal of ECOFIN’s 2001 criticism of Ireland’s fiscal stance represented a tragically missed opportunity to exploit external fiscal commitments to help overcome the political pressures that drive pro-cyclicality. McCreevy famously announced that “when I have the money, I spend it; when I don’t, I don’t.” He even used the occasion of the 1999 launch of “Understanding Ireland’s Economic Growth” to jeer at the economic perspective!
Instead of retrenchment, 2001 saw the introduction of the profligate SSIA scheme and continued income tax reductions. While such reductions had expanded the supply side in the earlier years of partnership by helping keep the lid on wage demands, their impact fell increasingly on the demand side as labour supply became increasingly inelastic (Barry and Fitzgerald, 2001).
Partnership, as Patrick Honohan has pointed out, contributed to a shifting of the tax burden away from income tax. We ended up excessively reliant on transactions-sensitive and property-sensitive forms of taxation (stamp duty, capital gains tax and VAT). Instead of tax reform we got further tax breaks for property investment, even as house price inflation soared. Areas like Achill and Clifden now look like Dublin suburbs.
The Bacon reports, which were supposed to take the steam out of the housing market, were conservative in the extreme. (One insider suggests they were ghost-written by the Department of Finance, which, if true, is shockingly indicative of the extent of regulatory and insider capture). I have previously cited research suggesting that the proportion of the price of a house that is accounted for by the site cost rose from around 15 per cent – which is apparently the norm by international standards – to some 40-50 per cent at the height of the property boom. The Kenny report of the early 1970s was asked to consider ways in which increases in the value of development land attributable to the decisions or operations of public bodies could be secured for the benefit of the community rather than of the property developers concerned. Nothing has been done about this over the last three decades. The rezoning decisions of public officials can still create massive overnight profits for private individuals. (I suggested this as a perfect example of what our penny catechisms used to call “an occasion of sin”!).
The problem lies, of course, in Fianna Fáil’s continuing entanglement with property developer interests. The only way I can see out of this is through wholesale reform of how political parties are funded, though Blair, Mitterrand, Kohl and many others all found ways of sidestepping such legislation. It remains a crucial area of policy design.
The housing boom was compounded by the failure of the Financial Regulator to hold bank lending to traditional standards of 2.5 times income and so forth. Many of us have long felt that the regulator’s office should not have been staffed from within the same institution (the Central Bank) that had purposely turned a blind eye to the Ansbacher and DIRT scandals.
The final connection I want to draw between the various policy errors concerns the excessively generous awards made under public-sector benchmarking Mark 1. This was arguably driven by the fact that traditional house-owning groups like the Gardaí, teachers and nurses found themselves increasingly excluded from the housing market. Under tighter credit conditions, the generosity of public-sector pension provisions and the permanency of public-sector employment would have ensured their housing market status. This was no longer the case. Hence the house-price boom can be seen as directly responsible for the generosity of these much-criticised awards.
The most recent research shows that public service salaries are some 20 percent higher than private sector salaries when comparing like-with-like in terms of education, experience etc. The real benefits or otherwise of social partnership will become apparent in the near future when this issue comes to be addressed. Supporters such as Paddy Teahon, secretary general of the Department of the Taoiseach when the process was established, argue that partnership has promoted a shared understanding among unions, employers and the government of the key mechanisms and relationships that drive the economy. (This was not apparent, though, in the debate preceding the devaluation of 1993). Other analysts viewed it as successful – in the early stages at least – by providing a mechanism to deliver wage moderation in exchange for income tax cuts. The Teahon view will be seen to be of validity if some agreement can be reached to reduce public-sector pay until the current crisis is overcome. The only politically viable option that could deliver this, many of us feel, would require that other more advantaged groups such as hospital consultants and the legal profession that receive much of their remuneration from the public purse are also faced with similar or larger reductions.
The issue of public sector reform has also come up for discussion. An underlying problem that is reflected in Irish unions’ choice of tax cuts in contrast to economic historian Barry Eichengreen’s (1996) characterisation of the Continental post-war “social contract” (which purchased wage moderation by guaranteeing construction of an efficient welfare state and maintaining high private-sector investment) is that the Irish electorate and Irish workers do not trust the state to be able to deliver on such a deal. Kingston (2007) argues (pretty convincingly, to my mind) that a Whistleblowers’ Charter could have prevented some of the major public-service failures of recent times, such as the lethal blood transfusions, illegal charges for long-stay institutional care, police criminality in Donegal, the PPARS health-service payroll system, the electronic voting machine fiasco, the failure of the Revenue Service to stand up to then-Taoiseach C.J. Haughey, and the corruption of the system by Justice Minister Sean Doherty. A more effective public service and a shift away from the crony capitalism that has characterised Irish politics would leave us on a much stronger institutional footing.
References
Barry, F., and J. FitzGerald (2001) “Irish Fiscal Policy in EMU and the Brussels-Dublin Controversy”, in Fiscal Policy in EMU: Report of the Swedish Committee on Stabilization Policy in EMU, Stockholm: Statens Offentliga Utredningar, 2001
Hunt, C. (2005) “Discretion and Cyclicality in Irish Budgetary Management 1969-2003”, Economic and Social Review, 36, 3, pp. 295-321
Eichengreen, B. (1996) “Institutions and Economic Growth: Europe after World War II”, in N. Crafts and G. Toniolo (eds.) European Economic Growth, Cambridge: Cambridge University Press.
Kingston, W. (2007) Interrogating Irish Policies, Dublin University Press (reviewed in the current issue of Economic and Social Review).
Lane, P. (1998) “On the Cyclicality of Irish Fiscal Policy”, Economic and Social Review, 29, 1, 1-16.